A Strange Flatness in the Housing Market

On Monday, the Federal Reserve released the consumer credit report for February and noted that the increase auto and student loans is commensurate with a decrease in the use of revolving credit. The financial market's response was small. And that's perfectly fine. The information in the report was known and expected.

The report does not include consumer lending in the real estate space. The available data there are becoming increasingly concerning, as home sales and mortgage lending are declining into the spring market. This is the exact opposite of what should be happening if consumer confidence and effective demand were rising.

The question for investors and the Fed to ponder now is whether auto loans are indicating a rising level of consumer confidence that is not yet being exhibited by the residential real estate market, but probably will be, or if the increase in auto purchases is an aberrant indicator.

Last week, in the column "Consumer Credit Is Reaching Its Limits," I referenced the Fed's consumer credit report for January, which indicated the same pattern as the February report. The increase in auto sales appears to be an indicator of resignation by consumers to the belief that the purchase of a home is now out of their reach.

I don't have any survey data to corroborate that directly, but the totality of the other available data implies that to be the case.

When home buyers, especially first-time home buyers, are preparing to purchase a home, they typically stop using other available credit. Put simply, home buyers don't borrow money to buy a new car if they are intending on an imminent purchase of a home, because they need all of their available credit to qualify for a mortgage.

Every real estate agent and mortgage lender is aware of this, and most of them ensure that clients are aware of this months before they make an offer to buy a house. The financial preparations made in anticipation of a spring or summer home purchase typically begin in earnest the previous year, between Thanksgiving and the end of the year.

During that time, most people who plan to buy a home will apply for a mortgage to become pre-approved and are counseled to suspend credit card use and not to use other credit for the purchase of an auto or home furnishings or whatever.

More revealing is that during that period of time, consumer spending by households with incomes above $90,000 declined quite dramatically, while spending by households with incomes below $90,000 conversely increased. Most first-time home buyers are in the group of households with incomes below $90,000.

Even more enlightening is that March spending did not increase at all. This most probably indicates that the surge in auto sales during the first part of the year is not an indicator of renewed consumer confidence and that this spending will not be transferred to the housing market this spring.

Throughout this period, the stocks of consumer-goods retailers that service the low, mid and high end of the market have trended sideways to down. Dollar Tree (DLTR) went from $56.64 to $51.05. Wal-Mart (WMT) started the year at $77.83 and is now $77.80. Burberry Group (BURBY) started the year at $48.03 and is now at $45.62. The performance of the other comparable stocks in each category has been very similar, with few exceptions.

All of this indicates substantial reduction in effective demand at all consumer levels and reflects the contraction in payroll tax receipts that I have written about recently.

I expect that between now and the next Federal Open Market Committee meeting on April 29 and 30, the markets, as measured by equity indices, especially the S&P 500, will increasingly exhibit an awareness of this and that the Fed will have to respond by not increasing its tapering program at that meeting.

The Fed may even decide to reverse some of it and announce intentions to buy more mortgages and/or long-term Treasury securities.

I believe the possibility of this occurring will also cause equity indices to rise as the meeting approaches. More problematic for the Fed and for Chairwoman Janet Yellen now is that economic activity is not responding to monetary policy, and concerns about the Fed being caught in a liquidity trap will increase. I'll write more about that issue as the FOMC meeting approaches.